IAS 32 Financial Instruments Presentation

 

IAS 32 Financial Instruments: Presentation

 

Background

IAS 32 outlines the financial instruments presentation. Recognition and measurement and disclosure of financial instruments are covered under IFRS 9 and IFRS 7, respectively. This standard describes the presentation of financial instruments by classified that into financial asset, financial liability and equity instruments.

It also prescribes guidance on classification of related interests, dividends and gains / losses, and the cases when financial assets and financial liabilities offsetting is possible.

IAS 32 reissued in December 2003 and further applied to annual periods start on or after January 1, 2005.

 

Objective

The objective of this Standard is to establish principles

• ·       to the classification of financial instruments into financial assets, financial liabilities and equity instruments;
• ·       to present financial instruments as liabilities or equity;
• ·       the classification of related interests, dividends, losses and gains; and
• ·       the circumstances in which financial assets and liabilities must be offset.

The principles in this Standard complement the principles for recognizing and measuring financial assets and liabilities in IFRS 9 Financial Instruments, and for disclosing information about them in IFRS 7 Financial Instruments: Disclosure.

 

Scope

IAS 32 is applied when presenting and disclosing information on all types of financial instruments with the following exceptions:

• interests in subsidiaries, associates and joint ventures that are accounted for under IAS 27 Consolidated and separate financial statements, IAS 28 Investments in associates or IAS 31 Interests in joint ventures (or annual periods starts on or after January 1, 2013 , IFRS 10 Consolidated financial statements, IAS 27 Separate financial statements and IAS28 Investments in associates and joint ventures). However, IAS 32 applies to all derivatives on interests in subsidiaries, associates or joint ventures.

• employers' rights and any obligations under employee benefit plans (see IAS 19 Employee Benefits)

• insurance contracts (see IFRS 4 Insurance Contracts). However, IAS 32 applies to derivatives that are embedded in insurance contracts if IAS 39 must account for them separately.

• financial instruments that are within the scope of IFRS 4 because they contain a discretionary participation feature are only exempt from applying paragraphs 15-32 and GA25-35 (analysis of debt and equity components) but are subject to all others IAS 32 requirements

• contracts and obligations as per share-based payment transactions (see IFRS 2 Share-based payment) with the following exceptions:

o       this standard applies to contracts within the scope of IAS 32.8-10

o       paragraphs 33 to 34 apply when accounting for own shares purchased, sold, issued or     canceled by employee stock option plans or similar agreements

 

IAS 32 applies to those contracts to buy or sell a non-financial item that can be settled net in cash or any other financial instrument, with the exception of contracts that were concluded and continue to be retained in order to receive or deliver a financial article of in line with entity's expected purchase, sale or use requirements.

 

Key definition

Financial instrument

Any contract that creates a financial asset of one entity and correspondingly a financial liability or equity instrument of another entity. 

Financial asset

Financial asset is any asset that is:

• ·       cash
• ·       equity instrument of any other entity
• ·       a contractual right

o   to receive cash or any other financial asset from another entity; or

o   to exchange financial assets or liabilities with another entity under conditions that are possibly favourable to the entity; or

• ·       a contract that will or may be settled in the entity's own equity instruments and is:

o   a non-derivative for which the entity is or may be obliged to receive a variable number of the entity's own equity instruments

o   a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity's own equity instruments. For this purpose the entity's own equity instruments do not include instruments that are themselves contracts for the future receipt or delivery of the entity's own equity instruments

o   puttable instruments classified as equity or certain liabilities arising on liquidation classified by IAS 32 as equity instruments

 

Financial liability

Financial liability is the liability which is a:

• ·       a contractual obligation:

o   to deliver cash or another financial asset to another entity; or

o   to exchange financial assets or financial liabilities with any other entity under conditions that are potentially unfavourable to the entity; 

• ·       a contract that will or may be settled in the entity's own equity instruments and is

o   a non-derivative for which the entity is or may be obliged to deliver a variable number of the entity's own equity instruments or

o   a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity's own equity instruments. For this purpose the entity's own equity instruments do not include: instruments that are themselves contracts for the future receipt or delivery of the entity's own equity instruments; puttable instruments classified as equity or certain liabilities arising on liquidation classified by IAS 32 as equity instruments

 

Equity instrument

Any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.

Fair value

the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction.

The definition of financial instrument used in IAS 32 is the same as that in IAS 39.

 

Puttable instrument

A financial instrument that gives the holder the right to put the instrument back to the issuer for cash or another financial asset or is automatically put back to the issuer on occurrence of an uncertain future event or the death or retirement of the instrument holder.

 

Classification as liability or equity

The fundamental principle of IAS 32 is that a financial instrument should be classified as a financial liability or an equity instrument according to the substance of the contract, not its legal form, and the definitions of financial liability and equity instrument.

Two exceptions to this principle are certain instruments with a put option that meet specific criteria and certain obligations arising from settlement. The entity must make the decision at the time the instrument is initially recognized. The classification is not subsequently modified according to the changed circumstances.

A financial instrument is an equity instrument only if:

(a) the instrument does not include any contractual obligation to deliver cash or another financial asset to another entity and

(b) if the instrument will be settled or can be settled in the issuer's own equity instruments, either :

• ·       a non-derivative that does not include any contractual obligation for the issuer to deliver a variable number of its own equity instruments; or
• ·       a derivative that will be settled only by the issuer by exchanging a fixed amount of cash or any other financial asset for a fixed number of its own equity instruments.

Illustration - preferred shares

If an entity issues preferred (preference) shares that pay a fixed dividend rate and have a mandatory redemption function at a future date, the essential thing is that they are a contractual obligation to deliver cash and should therefore be recognized as a liability . In contrast, preferred shares that do not have a fixed maturity, and where the issuer has no contractual obligation to make any payments are equity. In this example, although both instruments are called preferred shares, they have different contractual terms and one is a financial liability, while the other is equity.

Illustration - issuance of fixed monetary amount of equity instruments

A contractual right or obligation to receive or deliver an amount of its own shares or other equity instruments that varies so that the fair value of the entity's own equity instruments that are received or delivered equals the fixed monetary amount of the right or contractual obligation is a liability.

Illustration: one of the parties can choose how an instrument is settled

When a derivative financial instrument gives a party an option on how it is settled (for example, the issuer or the holder may choose to settle net in cash or by exchanging shares for cash), it is a financial asset or a financial liability, unless all settlement alternatives would result in it being an equity instrument.

 

Contingent settlement provisions

If, as a result of contingent settlement provisions, the issuer does not have an unconditional right to avoid settlement through the delivery of cash or another financial instrument (or otherwise settle in a manner that would be a financial liability), the instrument is financial liability of the issuer, unless:

• ·       the contingent settlement provision is not genuine or
• ·       the issuer can only be forced to settle the obligation in the event of the issuer's liquidation or

·       the instrument has all the characteristics and meets the conditions of IAS 32.16A and 16B for instruments with a put option.

 

Instruments with a put option and obligations arising from the settlement

In 2008 February, the IASB revised IAS 32 and IAS 1 ‘’Presentation of Financial Statements’’ for the balance sheet classification of financial instruments which put option and any obligations occurring only from settlement. Result of the alterations, some financial instruments that currently meet the definition of a financial liability should be classified as equity because they present the residual interest in the entity's net assets.

 

Classifications of rights issues

In 2009 October, the IASB issued changes in IAS 32 on the classification of rights issues. For rights issues which are offered by a fixed amount of foreign currency, current practice seems to require that such issues be accounted for as derivative liabilities. The amendment founds that if said rights are issued proportionally to all existing shareholders of an entity in the same class for a fixed amount of currency, they must be classified as equity regardless of the currency in which the exercise price is denominated.

 

Compound financial instruments

Some financial instruments (which may called compound instruments) have a liability and equity component from the issuer's perspective. In that case, IAS 32 requires component parts to be accounted for and presented separately according to their content, according to the definitions of liability and equity. The division is made at the time of issuance and is not reviewed for subsequent changes in market interest rates, share prices or any other event that changes the probability that the conversion option will be exercised.

 

To illustrate, a convertible bond contains two components. One is a financial liability, that is, the issuer's contractual obligation to pay in cash, and the other is an equity instrument, that is, the holder's option to convert to ordinary shares. Another example is debt issued with warrants to purchase removable shares.

The cases when the initial carrying amount of any compound financial instrument is needed to be assigned to its equity and liability components, the equity component is allocated the residual amount post deducting the amount considered separately from the fair value of the instrument as a whole for the liability component.

Interest, dividends, gains & losses related to an instrument categorized as a liability needs to be reported in profit & loss. This represent that the dividend payments on preferred shares categorized as liabilities should be treated as expenses. Alternatively, distributions to holders of a financial instrument categorized as equity should be charged directly against equity instead of earnings.

The transaction costs of an equity transaction should be deducted from equity. Transaction costs associated to the issuance of a compound financial instrument should be assigned to the liability and equity components in share to the allocation of income.

 

Treasury shares

The cost of an entity's own equity instruments that it has repurchased ('treasury stock') is deducted from equity. The gain or loss is not recognized in the purchase, sale, issue or cancellation of own shares. Treasury shares may be acquired and held by the entity or by other members of the consolidated group. The consideration paid or received is recognized directly in equity.

 

Interest, dividends, losses and gains

Interest, dividends, losses and gains related to a financial instrument or a component that is a financial liability will be recognized as income or expenses in profit & loss. Distributions to holders of an equity instrument will be recognized by the entity directly in equity. The transaction costs of an equity transaction will be accounted for as a deduction from equity.

 

Offsetting a financial asset and a financial liability

IAS 32 also prescribes rules for offsetting financial assets and financial liabilities. Specifies that a financial asset and a financial liability must be offset and the net amount reported when, and only when, an entity:

·       carry the legally enforceable right to offset amounts; and

·       it intends to settle on a net basis or to realize the asset and settle the liability simultaneously.

Costs of issuance or reacquisition of equity instruments

The costs of issuance or reacquisition of equity instruments are accounted for as a deduction from equity, net of any income tax related benefit.

Disclosures

Financial instruments disclosures are in IFRS 7 Financial Instruments: Disclosures, and no longer in IAS 32.

The disclosures relating to treasury shares are in IAS 1 Presentation of Financial Statements and IAS 24 Related Parties for share repurchases from related parties.